Bankers’ bonuses

Tilting the playing field

Regime change in Europe

LONDON just became a less attractive base for bankers used to taking home bonuses worth many multiples of their basic salary. On March 5th EU finance ministers decided that European bankers’ bonuses should be capped at a maximum of one times their base salary, rising to two times if shareholders explicitly agree.

The declared aim of the bonus cap, which was the brainchild of the European Parliament, is to dampen the incentives for reckless risk-taking that in the past led to bank bail-outs and costs to the taxpayer. In practice, the choice facing banks is either to find a way to compete with rivals that are not bound by the cap, or to risk losing star employees to competitors.

George Osborne, Britain’s finance minister, was unable to block the measure despite arguing that it will simply drive up base salaries and add rigidity to the banking system. That is a view shared by many regulators, no friends of the banks. The cap is a departure from bank-capital rules currently in force, known as CRD III, which include remuneration guidelines aimed at encouraging a higher proportion of variable pay.

The impact of the new regime may take time to become visible. It is not due to come into force until 2014, and may only take effect after next year’s bonus round. In a small nod to British opposition, a bit of tweaking may be done to enable portions of deferred bonuses to be treated more leniently in the calculations. That would mean the maximum bonus could end up slightly larger than double base salary, but not by much.

Many banks had assumed the cap would be kiboshed. The realisation that it is going to become reality has sparked a panicky reaction. Some wonder about the potential for a legal challenge. Lawyers point out that the EU’s Lisbon Treaty forbids interference on pay by the European Parliament or European Council. Ministers said on March 5th that they see no basis for a challenge. They were not challenged on CDR III, which also deals with pay.

A legal contest is unlikely to interfere with the EU’s timetable, says Stephen Mavroghenis at Shearman & Sterling, a law firm. Given bankers’ public standing, they are unlikely to seek a head-on clash with the EU. The British Bankers Association is also coy about whether it will take legal action. Other champions of the City might dare: Boris Johnson, perhaps, the far-from-bashful mayor of London.

Where there are laws, there are bound to be loopholes. There is talk of complex schemes in which bankers are promised a large bonus pot in the future, which is made to look smaller by applying a high discount rate. Subsidiaries of non-EU banks are wondering whether their parent company counts as a “shareholder”. That would make it a lot easier for an American bank in London, say, to get approval for a doubling of bonuses than a European one.

But since all this may look like banks getting up to their slippery tricks again, the simplest response will be to raise base pay. Not for everyone, mind: average employees seldom see bonuses of more than 40-50% and even high-flyers are lucky to touch 130%. But for a handful of top bankers in Frankfurt, Paris and perhaps 5,000 of them in London, a higher fixed salary beckons. For a sense of how much higher, The Economist took figures on London-based banks’ 2010 remuneration from a new paper by Brian Bell and John Van Reenen of the London School of Economics, and worked out how far base pay would need to have risen that year for risk-taking staff to have taken home the same total pay with a 1:1 cap in place (see chart).

These numbers are only illustrative. Few would disagree that the banks’ bonus culture had to change after pre-crisis excesses. But going against the grain of variable pay is no answer. The cap will either drive the best people outside the EU and EU-domiciled banks, or add to fixed costs. Neither is welcome.